Seconds a Loan Modification Problem

Federal regulators are urging banks to be realistic about the value of their second liens so they don't obstruct modifications of first mortgages that they service for other investors.

Dealing with second liens has proven to be one of the stumbling blocks in modifying troubled first mortgages.

It can be difficult to get the second-lien investor to accept a buyout or agree to re-subordinate the second after the first mortgage is modified.

The chairmen of the House and Senate banking committees recently called on federal banking regulators to address this issue and to stop banks from carrying these home-equity loans at inflated values.
The Federal Deposit Insurance Corp. reminded banks that it is an "inappropriate" accounting practice to delay recognition of losses on second liens when property values are declining.

"The failure to timely recognize estimated credit losses could delay appropriate loss mitigation activity, such as restructuring junior-lien loans to more affordable payments or reducing principal on such loans to facilitate refinancings," the FDIC says in a letter to state bank executives.

The Office of the Comptroller of the Currency has not issued a similar reminder to national banks.

In a joint statement, all the federal regulators put the banks on notice that ownership of a second lien should not influence their decision to modify the first mortgage that they are servicing for other investors.

Banks that service the first and second mortgage on the same residential property may face "potential conflicts of interests," according to the joint statement issued by the Federal Financial Institutions Examination Council.

"A servicer's decision to modify the first mortgage should not be influenced by the potential impact on the subordinated lien and vice versa," according to the FFIEC.

An investor group recently told Congress that four banks own $44 billion in second liens and they also service 55% of all first mortgages.

The regulators stress that servicers have an obligation to modify the first lien if it would "produce a greater anticipated recovery" for the investors.

"Failure to do so would be a breach of the servicer's obligation to those owners/investors," the FFIEC says.

House Financial Services Committee chairman Barney Frank, D-Mass., and Senate Banking Committee chairman Christopher Dodd, D-Conn., have asked the Office of the Comptroller of the Currency to review accounting practices that allow banks to avoid recognizing losses on seconds when the first mortgage is underwater.

"Carrying these loans at potentially inflated values may contribute to resistance on the part of servicers to negotiate the disposition of these second liens," the committee chairmen said in a letter that was dated July 11.

Department of Housing and Urban Development officials also are concerned that second liens could cripple the Hope for Homeowners program that they expect to roll out soon.

The revamped H4H program is designed to refinance underwater mortgages into new Federal Housing Administration insured loans.

William Apgar, a senior advisor to the HUD secretary, told a Senate panel that he is working with the federal banking regulators at the present time as part of an effort to "come up with a fair compensation system" for second liens.